Editor’s Note: Related tickers: American Railcar Industries, Inc. (NASDAQ:ARII), Ford Motor Company (NYSE:F), General Motors Company (NYSE:GM), Herbalife Ltd. (NYSE:HLF), Textainer Group Holdings Limited (NYSE:TGH), Aircastle Limited (NYSE:AYR)
John Neff was an investing genius who viewed himself as “a low price-to-earnings investor.” During his 31-year tenure at Vanguard’s Windsor Fund, Neff was producing annual total returns of 13.7%, on average, easily outperforming the market’s returns over the same time horizon. He followed an investment approach of picking undervalued stocks with reasonable earnings growth that were trading at earnings multiples between 40% and 60% below the valuation of the broader market. His investments were stocks that traded at low valuation multiples relative to their total returns as measured by the sum of forecasted earnings growth and dividend yield. Neff pursued stocks with a strong fundamental case for investment, earnings growth above 7%, and above-market total returns in relation to P/E ratios (i.e. the above-market GYP ratio).
What is the GYP ratio?
Today, the number of stocks that meet Neff’s strict selection criteria is small, just like many strategies with market-beating potential. Based on our adaptation of the total return ratio, the GYP ratio (forward earnings growth rate plus forward dividend yield, divided by forward P/E), below is a closer look at five stocks that seem undervalued relative to their total return potential when compared to the GYP ratio of the overall market. Neff’s paying attention to dividends stemmed from his belief that dividends were often overlooked as a component of total return that can help investors outperform the market.
American Railcar Industries, Inc. (NASDAQ:ARII), a leading North American manufacturer of hopper and tank railcars, has a GYP ratio of 2.5, a result of a forward (2014) EPS growth rate of 17.4%, forward dividend yield of 2.9%, and forward P/E of 8.1x. The company’s long-term EPS CAGR is 15.0%. American Railcar Industries, Inc. (NASDAQ:ARII)’s GYP ratio is 2.7 times higher than the comparable ratio for the S&P 500. The company’s payout ratio is 29% of the current-year EPS estimate.
We like American Railcar Industries, Inc. (NASDAQ:ARII)’s exposure to the booming energy sector and the long-term investment in railroad transportation as the most cost-efficient transportation means, particularly in the periods of rising energy prices. American Railcar Industries, Inc. (NASDAQ:ARII) is in a growth phase, coming out of 2012 as its best earnings year in history, which prompted the company to reinstate its dividend in Q4 2012, after a pause of more than three years. Its total revenues for 2012 were up 37%, driven by an increase in manufacturing segment revenues, while railcar shipments were up 51%. Revenue and EBITDA growth has continued into this year, driven by both manufacturing and leasing segment sales. Operating margins are improving year-over-year (holding up at 16%), partly as a result of cost reduction initiatives from prior years. The company’s business model of a vertically integrated supply chain is resulting in savings.
We also like American Railcar Industries, Inc. (NASDAQ:ARII)’s long-term operational environment. The long-term replacement demand and growth will be driving demand for freight cars, both of which have favorable trend characteristics. The average age of covered hoppers is 20 years and the average age of tank railcars is 16 years. Tank car deliveries are expected to grow through 2014, and will average 15,300 units annually over the next five years, about the same, on average, as the number of covered hopper deliveries. The company’s leasing operations are performing well and have a potential for notable growth in the future. American Railcar Industries, Inc. (NASDAQ:ARII)’s international expansion in India, and potentially in Russia, Saudi Arabia and Australia, could also boost financial performance in the future.